Five Key Takeaways from Jackson Hole

Fed Chair Powell’s speech noted that the “baseline outlook and the shifting balance of risks may warrant adjusting our policy stance,” with an emphasis on the downside risks to the jobs market in particular. He highlighted not only a slowdown in labor demand, which was evident in the weak July payrolls report, but also a marked slowdown in the supply of labor due to tighter immigration policies. At the same time, however, he struck a balance by noting the risk of inflation and reaffirming the Fed’s resolve to prevent inflation from becoming entrenched. That said, the consensus opinion is that Powell left the door wide open for a rate cut at the September 16-17 meeting, though stopping short of committing to one. 

Notably, Powell observed that tariff-related inflation impacts would likely be short-lived, though he is clearly mindful that high tariffs may lead to higher and stickier prices, as they represent a one-time shift in price levels. He also noted that, to assess whether tariff-related inflationary pressures remain, he will focus on wage inflation and inflation expectations — both of which are well-contained, at least for now. The labor market is no longer out of balance, or tight, which should alleviate any persistent inflation through the wage channel. And despite running well above the Fed’s 2% inflation target, longer-term inflation expectations are well-anchored, signaling that the market continues to believe the Fed will be successful in ultimately taming inflation.

Powell unveiled updates to the Fed’s long-term policy framework with several important changes that got the market’s attention. First, the Fed has removed the explicit mention of the effective lower bound, which was a 2020 revision that highlighted risks when rates approach zero and the need for unconventional tools like quantitative easing. This seems to indicate that the Fed believes there are more conventional ways to provide monetary stimulus given that the current rate environment leaves plenty of space for cuts. Second, the new framework dropped the “make-up” strategy in favor of more flexible inflation targeting: In 2020 the Fed had adopted “flexible average inflation targeting” (FAIT), which allowed for inflation to run hot — above the 2% target — for a period of time to effectively make up for the fact that inflation had run below that target rate for so long. This change signals that the Fed will no longer tolerate inflation overshooting and will aim for that 2% inflation target at all times. Third, the framework revisions emphasize policy adaptability under a broad range of economic conditions. This gives the Fed a lot of flexibility with policy, effectively avoiding any stringent rules-based framework that could potentially drive commitments markets view as binding and result in imprudent policies.

Market reaction has been fast and decidedly “risk on,” with the S&P rallying more than 1% and the higher beta NASDAQ rising nearly 2%. Bond yields dropped across the yield curve as investors quickly priced in higher odds of a September rate cut — of note, odds of a September move had fallen to 75% in Thursday’s trading, but rose to over 90% after the speech. The U.S. dollar weakened — again reflecting the higher potential for imminent rate cuts. This market reaction is quite in keeping with historical precedent, and investors can reflect on past periods of monetary easing that — particularly when they occur outside of a recession — tend to precede or even coincide with healthy risk asset returns.